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Thomas Piketty's new book, Capital In The 21st Century is rather taking the economics world by storm. Admittedly, those who love the idea that we should be levying a serious wealth tax do seem to be those who would like to tax the rich more anyway. You know, those who would, one gets the impression, use the argument that kittens are cute as an excuse to raise tax rates on the rich. However, the more that people look at the details of his arguments there more holes there seem to be in them. And there's one that I've not seen mentioned elsewhere as yet (but of course I haven't possibly been able to keep up with all reactions to the book either) which concerns his idea of a wealth tax as a solution to r > g. It seems, on closer examination, to be an entirely counter-productive idea.

The basic analysis that Piketty wants us to understand is that in a world where the return to extant capital ("r") is greater than the general rate of growth ("g" ) then the society will be doomed to an ever greater concentration of wealth and inequality. For that old, already extant, capital could be growing at, say, 5%, while growth being lower at 2% (again, imagine) means that those who work for a living will have incomes rising more slowly than those going to the inheritors of capital. And thus the gap between the lucky sperm club and those chasing them will grow ever wider and we are doomed, doomed, to ever greater wealth inequality.

One possible response to this is, well, what's wrong with wealth inequality? Which isn't what certain people want to hear these days so Piketty's solution is that we should have a decent tax on wealth, thus reducing that wealth inequality. However, this runs into a problem which is the deadweight costs of the different forms of taxation.

Any tax levied, on whatever at all rates, means that there's some economic activity that doesn't happen just because we've levied the tax. That's what deadweight means in this instance. From the work of Sir James Mirrlees we've also got a good idea of which taxes have higher deadweight costs than others. Repeated property taxes have the lowest such costs and that's why land value taxation is such a good idea. Then comes consumption taxes (sales taxes and VAT), then income taxes and then, at the highest cost in lost economic activity for the revenue raised comes capital taxation. Wealth taxation is of course an extreme form of capital taxation (the less extreme version would be the taxation of returns to capital rather than the capital itself).

Given that we know all this, and Sir James does have a Nobel awarded for his study of optimal taxation systems and thus his views do carry some weight, there's a problem with Piketty's plan. Which is that deadweight costs are exactly the same thing as a reduction in g in his equation. So now think through what he's proposing. Our problem is that r > g. Therefore we must do something. But what we're going to do is the one thing which we know is most destructive of growth in g.

*Scratches head*.

That really doesn't sound like the most sensible thing ever, does it? Even if we were insisting that we've got to do something about r we'd rather like to do it while having the least possible effect on g. Which brings us to a point that Matt Yglesias made, which is that we can achieve very much the same effect, the one Piketty desires, by instituting a proper land value tax. And that, by the same argument, produces the least reduction in g and would thus aid in solving Piketty's identified problem much more neatly.

Another way of putting this is that even if we accept the Piketty diagnosis the standard economics of taxation tell us that a wealth tax isn't the solution while a land value tax might well be. And there's one further consideration. Piketty's wealth tax would require global cooperation to be instituted: a land value tax can of course be imposed within the borders of any one nation no matter what the neighbours say and it'll have exactly the same beneficial effect.